Today somewhat over half of US workers have no retirement coverage other than social security. Of those that do have some form of supplemental coverage the vast majority are in a defined contribution plan such as the 401K where the investment risk is shifted to the employee. The defined benefit plan where the investment risk falls on the employer has become a rare thing in private employment. The remaining defined benefit plans are to be found in public employment. Even there, there has been a trend of shifting in the direction of defined contribution. Such a change for federal employees was initiated during the Reagan administration and has been gradually phased in for new employees since the mid 80's. Various state and local governments have adopted forms of modification.
The crash of the great recession has created serious financial problems for many state and local government organizations. They have less flexibility in dealing with bumps in the economic road than the federal government does. California has been particularly hard hit because of the limitations of the power to raise taxes imposed by Prop 13. There have been several municipal bankruptcy filings there. Other sorts of issues are having an impact in other states and the latest news of Detroit moving to file has but the issue in the news.
Bankruptcy is a legal process that is intended to provide financial relief to individuals and organizations that have become financially insolvent. The basic idea in dealing with individuals is to provide people a fresh start. With private businesses it can be either a reorganization of a liquidation. Government entities are not usually liquidated. They might be merged with another government in some instances.
There has been increasing political debate about public employees. They are the sector where union representation remains most prevalent. That is one of the reasons that the pension plans are more employee friendly than they are in private industry. The issue of what will happen to the pension plans and health plans for retirees in these municipal bankruptcy proceedings is being addressed in this very heated political context.
The investors who have purchased the municipal bonds of the bankrupt cities are major players in the bankruptcy proceedings. They are obviously seeking to get as much of their investment returned as possible. Their interest are set against the other financial obligations of the city government. The commitments to retired employees are a major consideration.
When private companies go through bankruptcy their pension and health care plans may or may not be terminated or modified. If it is a chapter 7 liquidation they will be terminated and vested assets transferred to a trustee. In a chapter 11 reorganization the plans become a part of the bankruptcy proceedings and are under the authority of the federal bankruptcy court.
Municipal bankruptcies have been fairly infrequent occurrences between the great depression and the great recession. In addition to those presently in the process there are a number of other cities with serious financial issues. There are going to be some important legal test about the fate of public retirees in this process. It sets a conflict between federal law and state constitutions.
The state constitutions of Michigan and California have almost identical provisions prohibiting what lawyers call "impairment of contract."
Michigan: "No bill of attainder, ex post facto law or law impairing the obligation of contract shall be enacted."
California: "A bill of attainder, ex post facto law, or law impairing the obligation of contracts may not be passed."
Their impact, if any, on public employee pensions is a big issue in two pending municipal bankruptcies in California and Detroit's decision last week to seek relief for its debts, including pension obligations, via bankruptcy.
Detroit's bankruptcy petition, unlike those of Stockton and San Bernardino in California, directly seeks to reduce pensions.
Public employee unions have gone to state court in both states in an attempt to block the ability of the federal bankruptcy court to modify pension plans. The specific situation is a bit different in each city. The City of Stockton is attempting to protect the plans and force to bond holders to take the hit. The City of San Bernadino wants to reduce its payments to the plans. Bond holders in Stockton are trying to force a reduction in pension payments.
CalPERS originally relied on the "impairment of contract" provision in waging its legal battle, but Stockton's bankruptcy judge, Christopher Klein, has indicated that it would not be an effective barrier.
At one point, he ruled that contractual health care promises to retirees could be reduced because federal bankruptcy law carries more weight than state law, startling CalPERS lawyers.
"I've been party to impairment of millions of contracts and it's all constitutional," Klein declared during one proceeding.
This is going to be an important battle. Stay tuned.
1:38 PM PT: There is a separate chapter of the US Bankruptcy for municipal bankruptcies, chapter 9. It's provisions are somewhat different from CH 11.